Banks were left scrambling on Tuesday evening after weathering the one-two punch of the edict from the Australian Prudential Regulation Authority to "limit discretionary capital distributions" and consider "prudent reductions in dividends" and a subsequent and historic credit rating downgrade to A+ from AA-.

On Wednesday morning Westpac informed the market no decision has yet been made on the upcoming first half dividend while NAB said it would take the new instructions into account. Bank shares fell in early trade with each of the big four off between 2 per cent and 3.5 per cent.

The letter from APRA chairman Wayne Byres hit the desks of bank CEOs and chairman after market close on Monday around 5.30pm and follows in the footsteps of similar orders made by the Bank of England, the Reserve Bank of New Zealand, the European Central Bank and the Monetary Authority of Singapore.

APRA furthermore told banks and insurers distributions should only be made after discussions with the prudential regulator and should "seriously consider deferring decisions on the appropriate level of dividends until the outlook is clearer" and even then they should be at "a materially reduced level".

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BOQ's chief executive George Frazis, a former Westpac retail boss, withdrew the bank's first half guidance on the back of the COVID-19 crisis just two weeks ago.

The decision to defer the dividend follows the move from giant Spanish bank Santander which also chose to defer its dividend last week following orders from the Bank of England to cease distributions until the full impact of COVID-19 can be quantified.

Investors are expecting to receive a larger dividend in the second half of the year.

Three of the big four banks are due to report first half results over the next three weeks with ANZ the first cab off the rank three weeks from Thursday on April 30, Westpac on Monday May 4 and NAB on Thursday May 7. CBA - which reports on a traditional financial year - paid out shareholders $2 a share fully franked or around $3.5 billion just last week.

Adding insult to injury, global credit ratings agency Fitch downgraded the long-term issuer default rating of the four major banks to A- from AA+ on concerns about the fallout across Australia and New Zealand from the COVID-19 virus and the government measures being used to tackle the crisis.

Fitch noted a steep rise in bad and doubtful debts flowing from the crisis citing the prospect of 1 per cent of impaired loans for an elevated period of time.

Fitch said initiatives such as repayment holidays and funding for small businesses was only likely to provide a "partial offset".

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"We expect the deterioration to become more evident in six to 12 months, partially reflecting the concessions granted by the Australian Prudential Regulation Authority to allow banks not to treat repayment holidays and repayment deferrals as arrears or loan restructures," Fitch said.

"However, a sharp rise in unemployment and the disruption caused by the restrictions imposed by governments to limit the pandemic is likely to escalate non-performing loans during 2021."

Westpac was among the first to respond to the downgrade saying Fitch noted the bank was "well capitalised to withstand the short-term consequences" and believed the bank had a "reasonable buffer".

Analysts seized on the developments saying they signalled the end of elevated payout ratios at the big four and they were likely to usher in a new period of capital conservatism.

Evans and Partners analyst Matthew Wilson said cutting dividends now was the right thing to do and would significantly reduce the risk of dilutive and expensive capital raisings further down the track.

"Dividends are risky optional distributions of excess free cash flows. They are buffers, they are not coupons," Mr Wilson said in a note to clients late last night.

"Accordingly, we cut, our already low estimates of major bank dividends, for the next 12 months by 50 per cent. We expect dividends beyond this to be reset at 50 per cent to 60 per cent pay-out levels and fluctuate directly with the level of earnings."

How the coronavirus is changing markets, business and politics.

James Frost writes about banking, funds management and superannuation. Based in Melbourne, James has been reporting on specialist business and finance topics for 15 years. Connect with James on Twitter. Email James at james.frost@afr.com

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